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Hi Olya,

How do you calculate normalized earnings?


This is just another way of saying regular earnings net of one-time charges and additions. Also, when normalizing earnings you can if you want take an average of the last several years to smooth out spikes that might occur in some cyclical companies before doing a sum of discounted cash flows valuation.

But the main thing is taking out one-time charges and additions. When an earnings report is announced they news will report unusual charges generally.

An example is Coinstar -

http://seattle.bizjournals.com/seattle/stories/2002/07/29/daily29.html

Excluding a one-time charge of $3.8 million from the early retirement of $36 million in high-yield debt, the net income was $4.5 million, or 20 cents per share. That figure bested the company's previous guidance, issued with its first-quarter earnings release, of $3 million to $3.6 million in earnings on revenue of about $36 million.

A year ago, the Bellevue-based company had revenue of $31.2 million, and had a net loss of $345,000, or 2 cents per share, which included a one-time charge from discontinued items of $5.9 million.


Normalized earnings in this case would be $4.5 million or .20 cents a share

If you notice too the company had a "one-time charge the year before" In this case the charge was included in the net income of that resulted in the report loss of $345,000. If you remove this charge, net income would have been positive or approximately 5.4 million or $5.9 - $345,000.

Already there is a warning. When a company produces regular one-time charges it starts to look as if it is part of doing business. If Coinstar as an example began charging these 'one-time charges regularly' you might decide you need to keep them in the normalized earnings amount that you are using since they are becoming regular occurences. But two does not make it regular, but it is something that one would have to watch.

I seldom average the earnings unless the companies earnings show a series of positive and negative earnings over the last several years. Many cyclical companies might have earnings that look like this.

2002 -.20
2001 .47
2000 -.30
1999 .27

Although, earnings reports are seldom this lumpy. If you believe growth now would be positive, and the company will grow earnings by 15%. You might decide rather than using the last negative figure to begin your calculations for growth, you might want to average the last 4 years to get an average earnings for the 4 year period. Or .24

.24 cents base with 10 million share outstanding give you a net income of 240,000 for your normalized earnings base.

You can then compound that by your estimated growth rate of 15%
Or 482725.8

Or 240,000 * (1.15 ^ 5)
or simply 240,000 * 1.15 * 1.15 * 1.15 * 1.15 * 1.15 = 482,725.8

What this tells me is that a base of $240,000 growing at a compounded rate of 15% will grow to 482,725.8 in five years. If the shares outstanding is still 10 million shares this would represent an earnings per share growth of .48 per share rounded off.

But to keep things simple

Just remember to make sure that one-time charges should be excluded from net income. And one-time additions should be excluded too. Additions can be used to inflate earnings incorrectly. For instance if a company sells assets which happens quite often. They can report this as part of the earnings for that year. Unfortunately, this is not going to repeated often, so earnings are artificially inflated.

A company can not increase earnings by continually selling assets or eventually there will be no company left.

I hope I have not confused you. Just simply make sure that earnings that are reported do not have charges or additions included. The news article that reports these earnings should discuss any one-time events.

tom



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